The first law is powerful. It explains a good deal about the business world, such as why the U.S. steel industry lost so much market share to the Japanese, how Emerson Electric has managed to stay at or near the top of its markets for so many years, why CEOs regularly claim (and actually seem to believe) that their competitors are colluding or "dumping" goods, how Southwest Airlines makes money in a business that everybody else thinks is one of the worst around, why Polaroid never succeeded in digital photography despite a sizable technological lead, and why your chief competitors may be widening the gap between their companies and yours at this very moment.
Some MBA students learn the tool known as the experience curve, a downward-sloping curve that shows the relationship between accumulated experience in an industry and the long-term decline in costs and prices (expressed in constant dollars). The experience curve takes a common-sense observation—the more often a task is done, the less it should cost to do it—and gives it mathematical expression, hence predictive power. But even those who learn the tool in the classroom seldom apply it rigorously in their businesses. And many managers have an incomplete understanding of the nuanced competitive economics that define their business, so they set targets based on the wrong curve.
The experience curve works in almost all situations. If a company doesn't obey it, at least one of its competitors invariably does; the competitor can therefore lower its prices and attract customers from others.
Implications for the general manager:
Read about the second law, "Position dictates strategy"
- Determine what unit of value your customers are really buying and all the competitive alternatives they are considering.
- Construct accurate cost and price experience curves for your industry, your company, and each of your competitors.
- Assume that your future prices will be determined by the experience curve. Plan and budget accordingly.
- Act to ensure that every component of your costs is declining, so that they are where they should be on the experience curve. Set annual budgets and targets based on the cost position necessary to remain on the curve. Choose your suppliers carefully, based on their cost position and experience-curve performance; manage the costs you incur from them based on experience-curve expectations, and draw up your contracts accordingly. Look for opportunities to help your suppliers manage their costs down appropriate experience curves.
- Watch for price umbrellas. Capitalize on them where you can, but be prepared for them to collapse.